Advanced Fibre Communications, Inc

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Advanced Fibre Communications, Inc.

1465 North McDowell Boulevard
Petaluma, California 94954
U.S.A.
Telephone: (707) 794-7700
Fax: (707) 794-7777
Web site: http://www.fibre.com

Public Company
Incorporated: 1992
Employees: 773
Sales: $333.5 million (2003)
Stock Exchanges: NASDAQ
Ticker Symbol: AFCI
NAIC: 334210 Telephone Apparatus Manufacturing

Operating out of Petaluma, California, publicly traded Advanced Fibre Communications, Inc. (AFC) offers multi-service broadband solutions to more than 800 telecommunication companies. AFC's products provide a connection between a telecom's central office and end users, with the ability to deliver not only voice but also video and high-speed internet services over a single network infrastructure. Moreover, AFC technology allows customers to enter the broadband era using an existing network. In this way, telecoms can maximize their previous investment in copper wire technology without the immediate need to engage in the costly conversion to a fiber-optic network. AFC's customers range from regional Bells to small Third World telephone companies. The company maintains sales offices in California, Florida, Kansas, Texas, and Mexico, and research and development and technical assistance offices in California, Florida, and Texas.

Founding the Company in 1992

AFC was founded in May 1992 by Donald Green, James Hoeck, John Webley, and Henri Sulzer. Hoeck and Webley were engineers with DSC Communications, who struck out on their own to design a product ultimately named the Universal Modular Carrier, or UMC 1000. The UMC 1000 was a variation on digital loop carrier technology (DLC) developed in the early 1980s, which used fiber to connect highly concentrated groups of customers, such as those found in a housing development or a rural community, to a telephone company's central office. Because fiber was not used in many locations, Hoeck and Webley developed the UMC 1000, which could use traditional copper wire to connect as few as six and as many as 672 subscribers.

Hoeck and Webley enlisted Donald Green, because of his reputation, management skills, and proven ability to attract venture capital. Green was regarded as the founding father of "Telecom Valley"—Sonoma County, California, which became the home of a number of telecom services companies, many of which had ties to the British-born Green. After receiving an engineering degree from the British Institute of Electrical Engineers, he worked as a design engineer, first with British Telecom, and later with U.K.-based RCA Standard Tele Cables and Lynch Communication Inc. He began his career as an entrepreneur in 1969 with the launch of Digital Telephone Systems, a Novato, California-based company that developed digital loop carriers for long distance signals. He later sold the business to Harris Digital Telephone Systems, where he served as vice-president until his first attempt at retirement in 1986. A year later he founded another start-up company, Optilink Corporation, a Petaluma company that developed a fiber digital loop carrier system called Litespan, supplemented later by an expanded version called Starspan. (Hoeck and Webley were both Litespan engineers who left in 1990 to cofound a design consulting company, Quadrium, before starting AFC.) In 1990 Green sold the business to DSC Communications, a Plano, Texas-based company, for $54 million. After staying on as a vice-president of DSC and president of DSC Optilink, in 1991 he retired a second time, only to change his mind a year later when he agreed to become involved in the creation of AFC.

One of the first moves that AFC made in 1992 was to enter into an agreement with the government of Taiwan and its Industrial Technology Research Institute (ITRI) to jointly develop telecommunications technology. It appeared to be a good deal at the time, bringing the young company much needed funding, engineering resources, and credibility. In exchange, ITRI and its member companies received the right to sell a European version of the UMC 1000 to markets outside North America on a royalty basis until 2002, after which ITRI members would be allowed to sell the technology anywhere in the world without paying a royalty. Because the two partners were competing against one another in a number of international markets, tensions developed, and eventually led to litigation. Before matters reached that point, however, AFC was already embroiled in legal problems.

In April 1993, Green sued DSC, claiming that the company still owed him millions of dollars for the stock he sold three years earlier. Several months later, in July 1993, DSC sued AFC for $20 million, claiming that it owned the UMC 1000 because the system relied on proprietary information used in the Litespan and Starspan products. Green responded by having AFC sue DSC, charging the Texas firm with violating antitrust provisions and engaging in sham litigation and industrial espionage. Green told Fibre Optics News that DSC was "attempting to put a competing company out of business by inappropriately using the legal system." He also suggested that DSC did not even care if it won the case: "All they have to do is spend enough of our money that we can't continue in business."

Installing the First UMC System in 1993

While the DSC litigation moved slowly through the court system, AFC began to ship its product. The first UMC 1000 system was installed in Mexico in 1993. Within a year a dozen countries adopted the technology. In the United States the first customer was the Sioux Valley Telephone Company, located in South Dakota. By mid-1994, some 40 systems were installed in the United States. Also in 1994 AFC entered into a joint venture with Tellabs Operations to develop a system that could transmit telephone and cable television service into a home over a single line. AFC would sell the product to telephone companies and Tellabs would market to cable companies. Revenues during these early years grew at a rapid pace for AFC, totaling just $620,000 in 1993, then increasing to $18.8 million in 1994 and $54.3 million in 1995. The company also turned profitable in 1995, posting net income of $2.3 million.

In June 1996, after three years in court, AFC reached a settlement with DSC. Although the terms were not publicly disclosed at the time, both sides acknowledged that neither company would be denied the use of its own technology, and it was later reported by Communications Week that AFC agreed to pay $10.1 million in cash and 719,424 shares of stock to settle the matter. Because Tellabs owned an interest in AFC, it was included in the settlement, but the relationship between the partners would soon come to a close when their joint venture was dissolved in 1996.

AFC was only free of litigation for a brief period. In July 1996 it filed suit against ITRI and its member companies for breach of contract, trade secret misappropriation, and other claims. A month later ITRI member companies sued AFC, alleging breach of contract. This litigation would be settled two years later when the two sides reached an agreement that awarded three Taiwanese telecom companies a license to produce and sell the European version of what was now older AFC technology. In return, AFC received an undisclosed payment plus royalties.

On a far more positive note, in 1996 AFC completed a highly successful initial public offering of stock. Underwritten by Morgan Stanley & Co., Merrill Lynch & Co., Cowen & Company, and Hambrecht & Quist, the offering netted AFC approximately $118.1 million. Initially priced at $25, the stock quickly soared to $47 by the next day. A major cause for investor confidence was the adaptability of the UMC 1000, able to help telecoms in the switch from copper wire to fiber optics, and also a highly desirable product for the global marketplace, especially in Third World countries where the UMC 1000 was an inexpensive way to create a telephone system. For the year, AFC saw its revenues grow to $130.2 million in 1996, with net income improving to $7.2 million.

Several months later, in May 1997, AFC began shipping the next generation of its digital loop carrier product, the UMC 1000 DLC. It was a far more robust system, able to provide standard telephone service and high-speed broadband service to as many as 2,000 users, and offer speeds of 155 megabits per second for a single subscriber, as opposed to 1.5 megabits per second for the UMC 1000. Moreover, standard telephone lines were capable of carrying only 64 kilobits of data per second, roughly 2,500 times less than the capacity of the UMC 1000 DLC. Management hoped that the new product would triple its market potential, since it could now sell to larger telecom companies, which represented the lion's share of the market. In fact, business in 1997 improved dramatically, especially due to new contracts in Asia, Latin America, and South Africa. Revenues for 1997 more than doubled the previous year's total, reaching $267.9 million, while net income grew fivefold to $36.8 million.

Green took steps to groom a successor to the CEO post. In July 1995, Carl J. Grivner, the former president of the Enhanced Business Services unit of Ameritech Corp., was named a vice-president with the understanding that he would eventually replace Green at the top. He became president and chief operating officer in January 1996, and in July 1997 he replaced Green as CEO. Green, who was now 66 years old, stayed on as chairman of the board and planned to remain involved in charting the company's course. His tenure as CEO, however, would last only one year.

Company Perspectives:

Through its market proven solutions, AFC enables carriers to deliver the most advanced broadband services to their customers, providing newer, richer experiences and more exciting ways for people to communicate.

Difficulties Arising in 1998

In mid-1998 AFC was stunned by a series of adverse developments. First, selling to the larger regional Baby Bells proved to be more challenging than anticipated, requiring costly levels of custom design and operational support. As a result, the company was forced to lower earnings estimates for the second quarter of 1998. Next, AFC had to admit that it was having problems at its China operations and that it had lost its largest customer, GTE. To make matters even worse, Grivner quit in order to become CEO for the Western hemisphere operations of Cable & Wireless plc, a London-based international telecommunications company. Investors punished the company, quickly bidding down its stock. In just two months, the stock lost almost three-quarters of its value, and AFC was rumored to be a takeover target, despite a poison pill provision the board of directors had installed only months earlier. The company also was beset with lawsuits initiated by disgruntled shareholders. Green was forced to take over as CEO on an interim basis, faced with the challenge of putting out fires while attempting to recruit Grivner's replacement. He asserted that the company continued to have excellent prospects because "the fundamentals of the company have not changed." By early October he had a verbal commitment from AFC's top candidate for the CEO post, allowing the unnamed executive six weeks to complete an employment contract. At the end of that period, however, the candidate informed Green that he was now considering a counteroffer from his current employer. Green immediately withdrew AFC's offer, explaining to the press, "You should live by your word. The guy wasted two months of our time, which is the most annoying thing."

Back to square one in the search for a new CEO, Green continued to head AFC. Finally, in April 1999 the company settled on a new president and CEO, hiring 50-year-old John A. Schofield, a senior executive at Minnesota-based ADC Telecommunications. Born in Australia, Schofield had lived in the United States for nearly 20 years and boasted 30 years of experience in selling telecommunications equipment around the world. He took over a company that was clearly in turmoil, its reputation with investors in tatters. According to Schofield, AFC "was drifting, in terms of customer focus. It was drifting in terms of product focus. And the internal processes associated with development were not in the shape that they needed to be."

Schofield's first step in turning around the company was to lower investors' expectations, a move that gave him some breathing room to effect some changes. He shut down engineering projects that he did not think could help the balance sheet in the near term. More important, with the help of an outside consultant, the Massachusetts firm of PRTM, he revamped the company's two-headed engineering organization, which previously had prevented AFC from pursuing a focused, long-term strategic plan. Now there was a single manager overseeing a unified engineering unit. Schofield withdrew from marginal foreign markets, in the process cutting about 9 percent of the company's global workforce, instead electing to target large European telecoms and distributors. He also beefed up the company's domestic sales operations to improve sales in the United States.

These steps soon paid off, as within 18 months AFC was posting record results. In 2000 AFC recorded sales of $416.9 million and net income in excess of $77.5 million. Also of note during 2000 was the acquisition of GVN Technologies, a Largo, Florida company that developed integrated access device equipment, the addition of which expanded AFC's product portfolio.

In 2001 Green retired as AFC's chairman at the age of 70, adhering to an age requirement that he had instituted. Schofield assumed the added responsibility. Overall, it was a difficult year for the telecommunications industry and AFC in particular, due to the effects of a slowing economy and the September 11 terrorist attacks. AFC experienced a major drop in sales, mostly occurring in the fourth quarter. As a result, management was forced to cut its workforce by 9 percent. For the year, sales fell to $327.6 million. Nevertheless, AFC remained a cash-rich company and was well positioned to wait until economic conditions improved. In 2002 it was able to invest in the future by acquiring AccessLan Communications, a San Jose, California, company that strengthened AFC's bid to be a technology leader in the development of next generation networks.

To adapt to changing conditions, in 2002 AFC restructured its supply chain to accommodate customers' preference for "just-in-time" purchasing. With the telecom industry still in the doldrums in 2003, AFC laid off another 11 percent of its workforce. The company essentially treaded water and remained profitable while waiting for customers to once again invest heavily in infrastructure. It also remained receptive to investing in the future through acquisitions if the right deal appeared. In February 2004, AFC paid approximately $240 million in cash to acquire Marconi's North American Access Group, part of London-based Marconi Corporation plc. The deal added a successfully deployed "Fiber-to-the-Curb" solution, greatly enhancing AFC's product offerings.